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Derivative Action: Definition, Example and Related Terms

What is a Derivative Action ?

A derivative action is a lawsuit brought by a shareholder on behalf of a corporation against a third party, typically the company's executives or directors. This is often done when the shareholder believes that the executives or directors have failed in their duties to the company, possibly involving breach of contract issues. Essentially, the shareholder steps into the shoes of the corporation to right a wrong that has harmed the company.

In a legal context, derivative actions are significant because they allow shareholders to take action when they believe the company's leadership is not acting in the company's best interest. This could be due to negligence, fraud, or other misconduct, including breach of fiduciary duties.

For example, if a company's CEO enters into a contract that is detrimental to the company's interests and violates their fiduciary duties, a shareholder might initiate a derivative action to hold the CEO accountable and seek remedies for the harm caused to the company.

Initiating a derivative action involves certain procedural requirements. For instance, the shareholder must typically show that they have been a shareholder at the time of the wrongdoing and that they have taken steps to request the company's board to address the issue before turning to the courts. This process helps ensure that derivative actions are used appropriately and not as a means of harassment.

Derivative actions play an essential role in corporate governance by providing a mechanism for shareholders to hold company leaders accountable and ensure they act in the best interests of the company and its shareholders.

Example(s)

  • Scenario Description
    A shareholder believes that the company's directors have mismanaged funds, harming the company's financial standing. The shareholder can initiate a derivative action against the directors on behalf of the company, claiming that their mismanagement constitutes a breach of fiduciary duty and has damaged the company.
    A company's CEO enters into a contract with a third party that violates company policy and results in significant financial losses. A shareholder could bring a derivative action against the CEO for breach of contract and fiduciary duty to recover damages for the company.

Related terms